Warren Buffett is widely regarded as the greatest stock market investor of all time. Not only has he built up a net worth of over $80bn by investing in stocks, but he’s also generated a return of around twice the S&P 500 return since 1965, which quite frankly, is an extraordinary achievement.
Is it possible to apply a Buffett-style strategy to the FTSE 100? Absolutely. Here’s what to look for.
Competitive advantage
If you want to invest like Buffett, one of the first things you should look for in a company when you’re doing your research is a competitive advantage, or ‘economic moat’ as he calls it. This is a particular advantage that enables the business to protect its market share and its profits from competing firms. “The most important thing is trying to find a business with a wide and long-lasting moat around it,” Buffett says.
A competitive advantage can take many forms. A strong brand that everyone knows and trusts is one example. High switching costs is another. Size advantages and technological advantages can also provide effective moats. The key is that it gives the company an edge over its competitors.
Profitability
Next, look at the company’s profitability. Buffett likes firms that are very profitable.
Here, check the company’s return on equity (ROE). This ratio demonstrates management’s ability to generate a return on the money invested in the business. The higher the better. Look for 10%+. But don’t just check last year’s ROE ratio – make sure you look at average ROE over five or 10 years.
Debt
Also check the firm’s debt levels. If a company has a high amount of debt on its balance sheet it could be vulnerable if economic conditions deteriorate. One useful ratio in this department is the debt-to-equity ratio. Buffett likes to see a ratio of less than 0.5.
Cash
Finally, examine the company’s liquidity. Does it have enough cash on hand to cover its short-term liabilities?
You can check this by looking at the current ratio. This is calculated by dividing current assets by current liabilities. Here, Buffett likes to see a ratio over 1.5. This indicates that a business has enough cash to meet its short-term debt obligations.
Buffett-style FTSE 100 stocks
Putting this all together, some names that come to mind within the FTSE 100 include:
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Rightmove. Its competitive advantage is that it’s the largest property website in the UK with a dominant market share and a strong brand. Five-year average ROE: 1,618%; long-term debt-to-equity ratio: 0.24; current ratio: 1.9.
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Hargreaves Lansdown. Its competitive advantage is that it’s the largest investment platform in the UK and it offers brilliant customer service. Five-year average ROE: 68%; long-term debt-to-equity ratio: N/A (no debt); current ratio: 1.8.
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Smith & Nephew. Its competitive advantage is that it’s an expert in a niche field – joint replacements. Five-year average ROE: 15%; long-term debt-to-equity ratio: 0.4; current ratio: 2.0.
These are just a few examples. There are plenty of other companies in the FTSE 100 that have Buffett-style attributes. The key to buying them at the best price, as he says, is to not shrink from price downturns and to be “greedy when others are fearful.”